Seven Tax-saving Year-end Tax Planning Ideas for Individuals

Dec 7, 2010

NEW YORK — Despite confusion created by recent and probable year-end
tax legislation changes, the 2010 federal income tax environment is still quite
favorable, noted Robin Christian, senior tax analyst for the Tax & Accounting
Business of Thomson Reuters. “However, we may not be able to say that
after 2010, therefore, tax planning actions taken between now and year-end may
be more important than ever. Be careful though—Congress could change the
ball game before the end of the year.”

Following are seven planning ideas to consider while there is still time to
act before the end of the year.

1. Accelerate Itemized Deductions into this Year. If your
Adjusted Gross Income (AGI) will be more than $170,000 ($85,000 if you are married
and file separately) next year, you may want to accelerate into 2010 your state
and local tax payments that are due early next year. You may also want to prepay
in 2010 some charitable donations that you would normally make in 2011. Why?
Because for 2010, the phase-out rule that previously reduced write-offs for
the most popular itemized deduction items (including home mortgage interest,
state and local taxes, and charitable donations) is gone, but is scheduled to
come back in 2011, unless Congress takes action to prevent it, which looks increasingly
unlikely.

If the phase-out rule comes back as expected, it will wipe out $3 of affected
itemized deductions for every $100 of AGI above the applicable threshold. For
2011, the AGI threshold will probably be around $170,000, or about $85,000 for
married individuals who file separate returns. Individuals with very high AGI
may have up to 80% of their affected deductions wiped out.

2. Think Twice Before Deferring Income into 2011. This strategy
makes sense if you are confident you will be in the same or lower tax bracket
next year, but the tax picture for 2011 is blurry. With just weeks left in 2010,
the fate of many tax provisions for 2011 and beyond is still unknown. The top
two rates have widely been expected to increase in 2011 from the current 33%
and 35% to 36% and 39.6%, respectively—at least for taxpayers earning
$250,000 or more ($200,000 or more if single). Therefore, if you fall into this
group, you might want to consider reversing the traditional strategy and accelerating
income into 2010 to take advantage of this year’s presumably lower rates.
However, legislators could still vote to delay any tax increase to after 2011.
"It may be wise to start now to identify ways you could accelerate some
of your 2011 income into 2010, but wait to pull the trigger on them until later
in the year when, hopefully, we will know more,” said Christian.

3. Time Your Investment Gains and Losses and Consider Being Bold. As
you evaluate investments held in your taxable brokerage firm accounts, consider
the impact of selling appreciated securities this year instead of next year.
The maximum federal income tax rate on long-term capital gains from 2010 sales
is 15%. However, that low rate only applies to gains from securities that have
been held for at least a year and a day. In 2011, the maximum rate on long-term
capital gains is scheduled to increase to 20%. That will happen automatically
unless Congress takes action, which currently seems unlikely.

To the extent you have capital losses from earlier this year or a capital
loss carryover from pre-2010 years (most likely from the 2008 stock market meltdown),
selling appreciated securities this year will be tax-free because the losses
will shelter your gains. Using capital losses to shelter short-term capital
gains is especially helpful because short-term gains will be taxed at your regular
rate (which could be as high as 35%) if they are left unsheltered.

What if you have some poor performing securities (currently worth less than
you paid for them) that you would like to dump? Biting the bullet and selling
them this year would trigger capital losses that you can use to shelter capital
gains, including high-taxed short-term gains, from other sales this year. If
you think your investments that are currently underwater are poised for a comeback,
you can buy them back after taking a loss as long as you do not reacquire them
within 30 days before or after the sale.

If selling many poor performing securities would cause your capital losses
for this year to exceed your capital gains, no problem. You will have a net
capital loss for 2010. You can then use that net capital loss to shelter up
to $3,000 of this year’s high-taxed ordinary income from salaries, bonuses,
self-employment, etc. ($1,500 if you are married and file separately). Any excess
net capital loss gets carried forward to next year.

Selling enough poor performing securities to create a big net capital loss
that exceeds what you can use this year might turn out to be a good idea. You
can carry forward the excess net capital loss to 2011 and beyond and use it
to shelter both short-term gains and long-term gains recognized in those years,
plus up to $3,000 of ordinary income each year—all of which may well be
taxed at higher rates after 2010. This can also give you extra investing flexibility
in future years because you will not necessarily have to hold appreciated securities
for more than a year to get better tax results.

4. Maximize Contributions to 401(k) Plans. If you have a 401(k)
plan at work, you can tell your company how much you want to set aside on a
tax-free basis for next year. Contribute as much as you reasonably can, especially
if your employer makes matching contributions. You turn down “free money”
when you fail to participate to the maximum match.

5. Take Advantage of Flexible Spending Accounts (FSAs). If
your company has heath or child care FSAs, before year-end you must specify
how much of your 2011 salary to convert into tax-free plan contributions. You
can then take tax-free withdrawals next year to reimburse yourself for out-of-pocket
medical and dental expenses and qualifying child care costs (depending on the
type of plan). Watch out, though, FSAs are “use-it-or-lose-it” accounts—you
do not want to set aside more than what you will likely have in qualifying expenses
for the year. And, starting in 2011, over-the-counter drugs (e.g., aspirin and
antacids) will no longer qualify for reimbursement by health FSAs, so you may
need to consider that when determining your 2011 contribution amount.

If you currently have an FSA, make sure you drain it by incurring eligible
expenses before the deadline for this year. Otherwise, you will lose the remaining
balance. For health FSAs, it is not difficult to drum up some items such as:
new glasses or contacts, dental work you may have been putting off, or prescriptions
that can be filled early. Also, for 2010, over-the-counter drugs still apply.

6. Adjust Your Federal Income Tax Withholding. If it looks
like you are going to owe income taxes for 2010, consider bumping up the federal
income taxes withheld from your paychecks now through the end of the year. When
you file your return, you will still have to pay any taxes due less the amount
paid in. However, as long as your total tax payments (estimated payments plus
withholdings) equal at least 90% of your 2010 liability or if smaller, 100%
of your 2009 liability (110% if your 2009 adjusted gross income exceeded $150,000;
$75,000 for married individuals who filed separate returns), penalties will
be minimized, if not eliminated.

7. Make Energy Efficiency Improvements to Your Home. A great
way to cut energy costs and save up to $1,500 in federal income taxes this year
is to make energy efficiency improvements to your principal residence. Basically,
if you install energy efficient insulation, windows, doors, roofs, heat pumps,
furnaces, central A/C units, hot water heaters or boilers, or advanced main
air circulating fans to your home during 2010, you may be entitled to a tax
credit of 30% of the purchase price. However, the maximum total credit you can
claim for 2009 and 2010 combined is limited to $1,500. Without Congressional
action, the credit will not be available after 2010.

Taxpayers should consult with a personal tax advisor before applying these
or other tax strategies.

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